UK Interest Rates Forecast for the Next 5 Years: What to Expect From the BoE?

In January 2024, UK inflation was 4%, below market expectations of 4.2%, and a considerable step down from October 2022 levels, when it hovered at about 11.1%. One of the key factors that influenced this decline was the Bank of England’s interest rate policy with consistent monetary policy tightening.

Other factors that contributed to January’s inflation print, as highlighted by the Office for National Statistics (ONS), included inflation rising at a much slower pace for furniture and household goods, as well as food and non-alcoholic beverages.

So, what is the UK interest rate forecast for the next five years? Read on to learn the key factors to consider and the analysts’ Interest rate predictions for the UK for 2024 and 2025 and beyond.

Key Takeaways

  • Interest rates in the UK have been held steady at 5.25% since September 2023.
  • The Bank of England expects inflation to fall to 2% soon, which could mean interest rate cuts as early as summer 2024.
  • However, the UK is currently in a technical recession, which it entered at the end of 2023, although hopeful signs of recovery are emerging.
  • UK interest rates could come down to about 3.25% by the end of 2025 if inflation continues to come down as expected, according to global financial institution ING.

UK Inflation Rate Analysis: Factors to Consider

The UK economy has recently slipped into a technical recession, which is defined as two consecutive quarters of negative economic growth. This technical recession was due to a combination of several factors, such as structural weakness in the UK labor market, consistently high inflation, low productivity growth, and unfavorable weather events.

The BoE also contributed to this technical recession by not giving clearer guidance, according to Ben Caswell, an economist at (NIESR).

As reported by The Telegraph, Caswell pointed out, “A little bit of forward guidance may have helped tip the UK out of a technical recession. In comparison with the Federal Reserve or the European Central Bank (ECB), the Bank of England has been a bit less communicative regarding when rate cuts are likely to take place.”

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Michael Brown, a market analyst at Pepperstone, wrote on Feb 13, 2024:

“All the talk of data-dependence, seeking more ‘confidence’ of inflation’s return to target, and refusing to give any calendar-based guidance as to the timing of cuts, has been a deliberate effort from policymakers to give themselves as much optionality as possible. In short, central banks can now reasonably cut whenever they desire and whenever they need to.”

Back in November 2023, in an interview with ChronicleLive, Andrew Bailey, governor of the Bank of England, said that he was very conscious of the impact of higher rents and mortgages on the lowest-income groups as well as the supply side of the economy. However, he also emphasized that the next leg of the fight against inflation would still be hard but necessary so that inflation could return to the 2% target.

“I recognise higher interest rates do have effects. They do have effects on mortgage costs, and they also have an effect on rental costs because they feed through. What I would say, to be honest, is that if we don’t get inflation down, it gets worse.”

He added: “It does concern me that the supply side of the economy has slowed. It does concern me a lot. If you look at what I call the potential growth rates of the economy, there’s no doubt it’s lower than it has been in much of my working life.”

Since then, Bailey has also pointed out that there are several hopeful signs that the current monetary policy strategy is working, such as January’s inflation being less than the BoE anticipated. “That’s good news, as far as I can tell,” mentioned Bailey to the Economic Affairs Committee recently.

The UK is not the only country to see an increase in an economic slowdown, with a similar pattern being seen globally, especially in Germany and China. China’s slowdown is especially relevant, as several large UK companies, such as Burberry, rely heavily upon the country for a large chunk of their sales. Germany’s central bank, the Deutsche Bundesbank, has recently warned that the country is likely already in recession due to dampened construction activity, weaker foreign industrial demand, and ongoing strikes.

A continuation of global conflicts, such as the Russia-Ukraine and Israel-Hamas wars, is also concerning at a time when the UK economy is already considerably weakened. In 2023, the UK’s GDP grew by a mere 0.1%. In comparison, in 2022, the UK’s GDP grew by 4.3%.

As such, a new European or Middle Eastern conflict can further hurt the UK economy through energy and food price increases.

Following the start of the Israel-Hamas conflict, the Yemeni Houthi rebel group has also started attacking a wide range of commercial ships traveling through the Red Sea and Suez Canal.  Several countries’ vessels have been attacked, such as Britain, the US, South Korea, and Saudi Arabia, amongst others.

This has forced many shipping companies, such as Maersk, Hapag Lloyd, and the Mediterranean Shipping Company (MSC), to halt transits through the Red Sea and instead go around the African continent.

This has led to shipping insurance costs being increased considerably, spilling over to transport costs and the final prices of many goods.

With the journey around Africa adding significant travel time and costs, several supermarket chains such as Tesco, Marks and Spencer, and Next have warned of some product prices rising. This, in turn, could refuel UK inflation if this situation persists over the next few months.

UK unemployment also dropped to 3.8% in the last quarter of 2023 from 4% in the previous reporting period. This was a notch less than analyst forecasts of 4% and was the lowest between November 2022 and January 2023.

The number of unemployed people dropped to 1.32 million, a drop of 87,000, while the number of employed people increased to 33.17 million, a hike of 72,000 people.


source: tradingeconomics.com

Coming to interest rate predictions in the UK, this resilient labor market report could also influence the Bank of England to hold interest rates steady for a little longer, as it may feel that the UK economy can tolerate tighter monetary policy for a bit more.

Has UK Inflation Already Peaked?

UK inflation could have peaked in October 2022, when it touched a high of 11.1%. However, the Bank of England and institutions such as the British Chamber of Commerce may not be so quick to rejoice. This is because future monetary policy decisions depend entirely on new economic and labor market data.


source: tradingeconomics.com

Although the Bank of England has already heavily signaled that interest rate cuts may come in summer 2024, the BoE governor Andrew Bailey is still maintaining a somewhat cautiously optimistic stance.

This is because January’s inflation, at 4%, was still twice the target rate of 2%, which has led to the central bank wanting to wait a little more for more decisive proof of cooling prices.

However, January’s report can lower the expectations for inflation to reduce in the coming month. This, in turn, may trickle down to wage conversations, impacting the labor market as well.

In any case, it may be too soon to really tell whether inflation has peaked or not, as the current Israel-Hamas war and Red Sea attacks still pose an ongoing threat.

If this war spirals into a wider Middle-Eastern conflict, energy prices can skyrocket once more, thus translating to higher inflation in the UK.

Shipping may also be impacted further if shipping companies keep having to divert their vessels. This may also lead to an increase in other commodity prices, such as food and supermarket goods.

Projected Interest Rates in 5 Years in the UK

The UK base rate forecast for the next five years may be crucial for the nation’s market to recover from the effects of the last few years.

One of the main factors that will influence UK interest rates in the next five years is the growth rate of the economy. The country’s growth was already one of the slowest among the G7 members, according to the International Monetary Fund’s (IMF) October 2023 World Economic Outlook.

In its January 2024 World Economic Outlook, IMF expected UK growth to be about 0.6% in 2024 and 1.6% in 2025.

International Monetary Fund (IMF)
International Monetary Fund (IMF), 2023

Sluggish UK Growth Could Cause Pauses in Interest Rate Hikes

If UK growth continues to stagnate, policymakers may be forced to consider a reduction in interest rates, especially since it has already entered a technical recession. This could be once inflation is more manageable and could very well be before it reaches the 2% target. This is because, at the current slowing growth rate, the nation’s economy may not have the luxury of sacrificing growth further for inflation.

Speaking of the UK interest rate forecast for the next five years, Piero Cingari, staff writer at financial news outlet Benzinga and former macroeconomic analyst at Capital.com, said:

“Five years already constitute a significant timeframe in the world of financial markets. If we reflect on the state of the world five years ago, we were grappling with negative interest rates in a substantial portion of the Western world. Inflation was virtually absent. There were also no wars on Europe’s doorstep nor a global pandemic.”

He added: “Many profound changes have occurred over just five years, rendering any predictions today regarding interest rates in the next five years somewhat speculative.”

“Currently, the interest rate market is factoring in a potential reduction of approximately 200 basis points in the Bank of England’s rates between 2024 and 2025. This is broken down into an anticipated 70 basis point reduction in 2024 (equivalent to nearly three 25 basis point cuts) and a further 125 basis point reduction in 2025 (equivalent to six 25 basis point cuts).

“Should the market’s pricing turn out to be accurate, interest rates in England would likely decrease to approximately 3-3.25% by the end of 2025. Beyond this timeframe, making precise forecasts becomes increasingly challenging. What appears to be gaining traction is a shift away from the pre-pandemic and post-financial crisis era, when interest rates remained near 0%.

“That era was characterized by trade liberalization. Reduced geopolitical tensions meant that inflation was consistently falling below central bank targets. If this period represents just a historical window, it is plausible to anticipate that central banks may opt to maintain positive interest rates in the years ahead,” Cingari explained.

Syed Muhammad Osama Rizvi, macroeconomic and energy analyst at Primary Vision Network, also supported this view. He highlighted: “The global monetary policy tightening is expected to prolong on the back of uncertainty and volatility, especially in the global energy markets.

“The core inflation levels are still high in many developed parts of the world. UK’s case is unique in that the economy has not been doing very well. It is probably one of the worst in the advanced economies.

“I believe the UK will soon start to unwind its rising interest rate policy, the country already seems to be on the cusp of recession. We can expect an expansionary monetary policy moving forward.”

Craig Erlam, senior market analyst, UK & EMEA at OANDA, believes that the BoE may potentially cut interest rates by the end of the second quarter this year due to UK inflation reports being quite promising.

Erlam told Techopedia:

“That’s despite one BoE policymaker, Megan Greene, pushing back against that, although it’s worth noting she does sit at the hawkish end of the committee, having recently been in the minority voting for a rate hike. While her concerns over wages and where interest rates will land in the future are perfectly reasonable, it seems markets are more aligned with the dovish end of the MPC.

“I expect many policymakers will continue to push back against markets for now until they can be absolutely certain that inflation has been controlled and is on a path back to 2%. A late pivot has likely always been the strategy and I expect it remains the case. Higher for longer remains the mantra but I suspect it won’t be too much longer now.”

In its interest rate predictions for the UK in 2024, ING expected that UK interest rates should drop from about 5.25% in the first quarter of 2024 to 4.24% by the end of the year. By the end of 2025, the bank sees interest rates at around 3.25%.

Capital Economics predicted that UK interest rates would likely come down to about 3% by 2025.

However, this is a slightly more upbeat long-term interest rate forecast for the UK than the general 3.25% priced in by the markets by 2025.

According to the BoE, interest rates are likely to come down to about 5.1% by the end of 2024, going further down to 4.5% in 2025 and 4.2% in 2026.

Analysts don’t provide UK interest rate forecasts for the next 10 years due to the complexity of factors that might significantly influence the future rate.

The Bank of England May be Thawing Soon

Although the Bank of England is still taking a cautiously optimistic approach, there are signs that it might consider a less rigid monetary policy in the coming months, maybe as soon as summer this year.

Most recently, the BoE revealed that inflation does not need to come back to the 2% target before the central bank can start cutting rates.

Bailey highlighted that the BoE was waiting for more improvement in wage growth, service prices, and the labor market before taking any decisive monetary loosening steps. However, he also highlighted that expectations for the central bank to slash rates sometime this year were not “unreasonable.”

“But it’s the progress of those three things. We don’t need inflation to come back to target before we cut interest rates. I must be very clear on that; that’s not necessary.”

However, when and by how much the interest rates can drop is yet to be revealed, as the official stance has been aggressively hawkish, in line with the US Federal Reserve, since the beginning of the pandemic.

The exact month from which monetary loosening may begin depends entirely on how incoming inflation, labor market, services, and GDP data turn out to be. This is to see how inflation and the broader economy react before taking any decisive monetary loosening steps.

In its latest February 2024 Monetary Policy Report, the Bank of England highlights, “The speed of price rises is slowing. Inflation has fallen from a peak of 11% in 2022 to 4% in December 2023. Petrol and utility prices have fallen over the past year, and some other prices are now rising much more slowly, including food prices.

“We expect inflation to fall further by the end of this year to around 2.75%. But there could be some bumps along the way between now and then. Lower oil and gas prices could mean that inflation temporarily drops to 2% for a brief period only to rise later in the year. We can’t rule out another global shock that keeps inflation high though.”

Craig Erlam pointed out:

“The Bank of England obviously won’t be swayed by the technical recession, as Governor Bailey alluded to recently, but weaker household spending may suggest demand isn’t as strong as they anticipated.

 

“With inflation expected to fall to target in the second quarter, maybe even further, the debate around rate cuts could intensify earlier than they would have otherwise thought. Slower wage growth would obviously help that along greatly.”

Speaking of the summer of rate cuts, Michael Brown stated:

“Though the, somewhat futile, game of guessing, and second-guessing, when central banks will kickstart easing cycles, and how deep these cycles will be, continues on a daily basis, consensus is rapidly forming around a single view – that most DM central banks will deliver the first 25bp cut somewhere between June and September, and that cuts will probably continue until around the middle of next year.”

Policy Changes Could Impact Interest Rates

The UK may need specific key policy changes for businesses. This is because profit margins have eroded significantly following the pandemic and the price shocks due to geopolitical events. This has also led to several companies reducing output, shutting down production completely, or outsourcing to cheaper countries.

The UK government could bolster local businesses through increased stimulus measures, tax breaks, and loans, amongst others.

The UK Spring Budget, due to be released on 6 March, is expected to be a very significant event due to 2024 being a general election year in the UK. As such, this could be the last budget before the election and could have considerable influence on the poll results.

Speaking of Spring Budget predictions, Tim Sarson, Partner, UK Head of Tax Policy, and Sharon Baynham, Director, Tax Policy, at KPMG, stated:

“The Chancellor will not be able to resist cutting the main rate of either income tax or national insurance. We would put our money on national insurance as it chimes with previous messaging on incentivising work and may be better received by the OBR. This may be the “rabbit” of the Spring Budget but, following the Autumn Statement, it feels a bit scrawny. It is not clear if there is sufficient headroom for a 2p cut in either.”

Tax relief measures, if actually implemented, could help enterprises to better manage expenses. As a result, they will also pass on fewer costs to consumers, thus decreasing cost-push inflation.

Similarly, the UK plans to implement increased support measures for unemployed young people. This includes career counseling, mental and physical health support, and plans to get people off benefits through its Back to Work Plan. As a result, the unemployment rate may also fall considerably.

These measures, or lack thereof, could go a long way in impacting inflation rates and the resulting monetary policy.

UK Interest Rate History

The UK interest rate history in the post-pandemic period has been quite rocky — over the past two years, the Bank of England has hiked interest rates 14 times.

Bank of England Database
Bank of England Database

This started in December 2021, bringing the current UK interest rate to 5.25%, where it has held steady since September 2023. This was done both in aggressive 0.50% hikes and a few more gentle 0.25% hikes, as the month-to-month situation demanded.

However, in the last four monetary policy meetings, the BoE has chosen to hold rates stable.

This spate of rising UK interest rates was due to several factors. Amongst these, soaring inflation and the energy crisis were significant factors, especially during the pandemic. The surge in demand following the lockdown restrictions also worsened inflation.

This was especially true since businesses struggled to get production back on track following profit margin cuts during the pandemic.

The Russia-Ukraine war was another shock, leading to rising energy prices and inflation. The conflict also caused considerable supply chain blockages and soaring food and input material costs.

Following the pandemic, the UK workforce also shrank considerably as more people suffered from long COVID-19 or cared for loved ones. Many others were laid off or could not afford childcare costs anymore, while others simply opted to leave the workforce, taking early retirement. This increased labor costs proportionately as employers struggled to find skilled labor.

In turn, they passed on the costs to final consumers, thus perpetuating the inflation cycle.

What is the Bank of England (BoE)?

The Bank of England, or the BoE, is the UK’s central bank. Founded in 1694, it is headquartered on Threadneedle Street in the City of London and is also the world’s eighth oldest bank.  It is responsible for developing monetary policy and keeping tabs on other banks in the UK, amongst other things. The bank is also responsible for regulating the money supply.

It is also a regulator for payments and financial systems and acts as a watchdog to ensure financial fraud and crime are controlled. The BoE also sets UK interest rates and inflation targets and works towards meeting them through various methods.

This can include raising or lowering interest rates as needed. Furthermore, it can also help bail out other banks if they are struggling.

In the last few years, the Bank of England, like other major central banks, has seen increased prominence due to its aggressive monetary tightening strategy. This has mainly been due to consecutive cost of living shocks because of the pandemic, the Russia-Ukraine war, and the resulting energy crisis.

FAQs

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References

  1. CPIH ANNUAL RATE 00: ALL ITEMS 2015=100 (Ons.gov)
  2. Monetary Policy Report – February 2024
  3. Consumer price inflation, UK: January 2024(Ons.gov)
  4. Our global economic and financial forecasts (Think.ing)
  5. ‘It’s official, we’re in recession.” Investment experts react to today’s ONS data showing UK in ‘technical’ recession (Ifamagazine)
  6. Bank of England pushed Britain into recession, economists say (Telegraph.co)
  7. The Summer Of Rate Cuts (Pepperstone)
  8. Bank of England governor warns of tough times ahead in battle to lower inflation(Chroniclelive.co)
  9. Economic Affairs Committee (Committees.parliament)
  10. The current economic situation in Germany (Bundesbank)
  11. Join the Vogue Business community (Voguebusiness)
  12. GDP first quarterly estimate, UK: October to December 2023 (Ons.gov)
  13. Maersk Operations through Red Sea / Gulf of Aden
  14. Here’s a live ticker on the Red Sea situation
  15. MSC Statement on MSC UNITED VIII Incident in Red Sea (Msc)
  16. Chaos in the Red Sea Is Starting to Bite Into Companies’ Profits (Bloomberg)
  17. M&S rings up better-than-forecast festive sales but cautions on Red Sea impact (Independent.co)
  18. Trading Statement – 4 January 2024 (Nextplc.co)
  19. United Kingdom Unemployment Rate (Tradingeconomics)
  20. Inflation Likely Peaked But Damage Remains (Britishchambers.org)
  21. United Kingdom Inflation Rate (Tradingeconomics)
  22. World Economic Outlook(Imf)
  23. World Economic Outlook Update (Imf)
  24. United Kingdom’s Long-Run Prosperity Hinges on Ambitious Reforms (Imf)
  25. New interest rate forecast – first cut sooner, end destination is 3% (Capitaleconomics)
  26. guce (Uk.finance.yahoo)
  27. Spring Budget 2024: Paving the way for the general election (Kpmg)
  28. Employment support launched for over a million people (Gov)
  29. Bankofengland (Bankofengland.co)
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Indrabati Lahiri
Financial Writer & Editor

Indrabati has over four years of experience as a financial reporter and editor, covering business, commodities, and macroeconomics. While contributing to Techopedia, she’s currently working as a Business Reporter at Euronews. Her articles can be found in other online publications, including Capital.com and IBM, among others. Indrabati holds an MSc in Investment Banking and an MA in English.